Capital expenditure has disappointed this year, in spite of companies across the globe continuing to hold historically high levels of cash.
Standard & Poor’s forecast is that spending – known as capital expenditure or ‘capex’ – will decline 0.5 per cent this year in real terms, based on first half-year data.
So is this a worry for equity managers and are they avoiding sectors that are cutting capex?
Matthew Beesley, Henderson Global Investors’ head of global equities, says the current cycle has largely been “capex-less”. He explains that with demand generally suppressed and following a large capex cycle in the run-up to 2008, this current cycle has so far been about sweating assets more intensively.
Mr Beesley says: “The fear is that in many sectors and in certain stocks, a capex recovery has been priced in. The reality is that we are seeing capex in certain sectors and end markets, such as North American trucks, but it’s not homogenous.”
He notes that with capex curtailed, cashflows have been strong and these have been used to pay down debt, increase dividends or generally de-equitise, and that with the merger and acquisition boom, “buying assets is the new capex”.
He says companies that are deploying capital in this way are generally getting rewarded for it in higher stock prices, thus creating a positive feedback loop. “Lower capex may be a worry for some stocks, but accretive deployment of capital is a good thing.”
Jeremy Podger, manager of the Fidelity Global Special Situations fund, is also not perturbed by the decline in capex.
“If we saw a massive pick up in global capex, we would be a bit worried because typically that comes towards the end of a cycle, when industries are very capacity constrained and just throw money at the problem.”
Andrew Milligan, Standard Life Investments’ head of global strategy, says equity managers look for capital discipline among the companies they invest in.
“Investors would be worried if companies were pulling back too much from capex and conserving cash because of a sharp downturn in the economy, but there are no signs this is the case,” he said.
He believes firms are rather being cautious about investment at a time of geopolitical and policy uncertainty. With the economic recovery looking intact and profit forecasts still positive, he says asset allocators still prefer equity to fixed income.
So which sectors are cutting and which are increasing their capital investment? Mr Beesley sees “plenty of pockets” of IT-related capex, but that European corporates remain wary of ramping up investment, given the uncertain demand environment, while “big oil” is in retreat.
Mr Podger says: “The big oil and gas companies are trying to rein back because they’ve been overspending compared to their cashflow in the past few years.
“Oil and gas accounts for nearly a quarter of overall capex, so it’s a big chunk, but within that area, we’re seeing a capex boom in shale oil companies in domestic US, so we have Halliburton in our portfolio.”
He has also added Caterpillar and Komatsu – big suppliers to the mining industry – to his portfolio in expectation of a jump in replacement capex for mining machinery next year. So even in the areas where capex is being pulled back, he sees opportunities.
He believes sectors where capex is decreasing include utilities, medical and shipping, whereas wireless, telecoms, internet, software, building materials and electrical equipment companies are increasing it.
So how does this impact managers’ views of equity markets and how much of their positive outlook was based on an increase in capex?
Mr Beesley says it is less a question of capex and more about how cash is reinvested.
“We want to invest in businesses that can positively surprise investors with their cashflow generation capabilities and then reinvest this cashflow accretively in growing their business or by returning cash to shareholders.”
Mr Podger says his generally positive view on equity markets was not based on capex expenditure as a reduction in capex is partly a factor of productivity gains.
“We are seeing global growth and industrial capex become more and more productive. Every $1 of spending gives you potentially more production, so productivity constantly improves,” he explains.
Mr Milligan says the capital-spending outlook was only ever a ‘minor positive’ in his pro-equity stance.
In any event, some believe S&P’s figures are skewed by mining and oil companies.
James McCann, Standard Life Investments’ UK and European economist, says the S&P Global Capex survey is dominated by the energy and materials sectors, which accounted for 42 per cent of business investment carried out in 2013.
“When excluding these sectors, capex is forecast to rise this year according to S&P,” he says.
He says S&P’s forecast does not include investment by small- and medium-sized enterprises, which in the EU account for approximately half of all capex.
Julian Chillingworth, Rathbone Unit Trust Management’s chief investment officer, adds that in the resources sector, company managements have bowed to shareholder pressure to reduce capex to boost profits and maintain dividend growth.
“These figures will rightly skew an omnibus number,” he says.
